|Has the new bull market begun? Or is the recent rally simply a correction to an over-sold condition? If your clients hope it is the former, but are reluctant to buy stocks for fear that it is the latter, then here is an option strategy that allows your clients to buy stocks without assuming all of the attendant risk.
The term married put refers to the simultaneous purchase of puts and stock on a share-for-share basis. Just like homeowner's insurance protects a house, put options can be purchased to protect stocks. A put option, remember, gives its owner the right to sell 100 shares (in most cases) of the underlying stock at a specific price (the "strike price") until the expiration date. An XYZ December 70 Put, for example, gives its owner the right to sell 100 shares of XYZ stock at $70 per share at any time until the third Friday in December.
Graph 1 illustrates the married put strategy in which 100 shares of XYZ stock is purchased for $72 and one XYZ 70-strike Put is purchased at for $3. As Graph 1 shows, during the life of the put, the maximum risk is $5 per share. For simplicity, commissions are not included in this example, but they must be considered in the analysis of a real situation.
There are two positive aspects of married puts. First, no matter how far a stock price might fall, the put owner has the right to sell at the strike price of the put. Second, if the stock rises, there is no upside limit on the profit potential. The negative aspects are that puts have a cost, and this cost increases the break-even point for the stock. Also, the protection has an expiration date.
Married puts are appropriate when your client is bullish on a stock but nervous about "something." That "something" could be an upcoming earnings report or a concern about the overall market. Married puts allow your clients to enter the market with limited risk during times that are perceived to be high-risk.
Because of the importance of tax considerations, the investor should consult with his/her tax advisor as to how taxes affect the outcome of this strategy.
Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options. Copies of this document are available from your broker or The Options Clearing Corporation, 400 S. LaSalle Street, Chicago, IL 60605. CBOE and Chicago Board Options Exchange are registered trademarks of the Chicago Board Options Exchange, Incorporated. 2002 Chicago Board Options Exchange, Incorporated, All Rights Reserved.
The term married put refers to the simultaneous purchase of puts and stock on a share-for-share basis. Just like homeowner's insurance protects a house, put options can be purchased to protect stocks...